Judicial Cooperation and Legal Interpretation in European Union Tax Law

JUDICIAL COOPERATION AND LEGAL INTERPRETATION IN EUROPEAN UNION TAX LAW

Robert F. van Brederodel

I. INTRODUCTION

The relationship between European Community (EC or Community) law and the national laws of its member states is2 complicated. The treaties establishing the European Communities have created a law system sui generis, i.e., separate from that of the individual member states, with its own terminology and underlying legal principles. Community law is the common internal law of the member states rather than a law between the states, as is the case in traditional international law. Beyond the mere creation of mutual rights and duties between the states, as under traditional international law, Community law regulates the relation between

I Dr. Robert F. van Brederode is a tax lawyer concentrating in the area of value added tax (VAT) and other transaction taxes. He has over 25 years experience in the field prac- ticing on both sides of the Atlantic, currently as a partner with International VAT Con- sultants. In addition, he teaches courses as an adjunct professor at New York University, School of Law, Graduate Tax Program. Previously, Dr Van Brederode was a partner with PwC, leading the Netherlands VAT & Customs practice, and professor of tax law at the Erasmus University, School of Economics. He can be reached at [email protected]. 2 Treaty of 25 March 1957 establishing the European Economic Community, 298 U.N.T.S. 11 (entered into force 1 January 1958); Treaty of 18 April 1951, establishing the European Coal and Steel Community (entered into force as of 23 July 1952); Treaty of 25 March 1957, establishing the EURATOM (entered into force on 1 January 1958). Together, EURATOM, ECSC and the EEC are the founding treaties of European integration as amended by later treaties. The ECSC expired on 23 July 2002, and since then the coal and steel sectors are incorporated within the legal scope of the EEC Treaty. The Maastricht Treaty of 1992 changed the name EEC to EC for the simple reason that the Community, beyond mere economic policy, is concerned with social, cultural and envi- ronmental policies. It also established the European Union (EU). The terminology may be confusing, especially to the non-European reader. It is important to realize that EC and EURATOM, with their common structures and institutions remain totally in place. The EU comprises the totality of the relations between the Member States, but is not a separate legal entity. The EU, therefore, is in essence a combination of supranational and intergovernmental power, but in the political sense only. 3 See, e.g., Case 26/62, Van Gend & Loos v. Neth. Inland Revenue Admin., 1963 E.C.R. 3; Case 6/64, Flaminio Costa v. E.N.E.L., 1964 E.C.R. 1194; Joined Cases C-6/90 & C- 9/90, Francovich v. Italy, 1991 E.C.R. 1-5357. FA ULKNER LA W REVIEW Vol. 1-1:53 the Community and its subjects, including member states and private and legal persons, and between these subjects amongst themselves.4 As a distinctive legal order, Community law regulates the powers, rights, and obligations of the Community and its subjects. Community law also provides for the procedures required for de-5 termining, adjudicating, and sanctioning infringements of the law. Community law is not common law or civil law; therefore, legal principles and precedent developed under common or civil law have no direct bearing on Community law. 6 Even if the same legal terminology is used, the meaning is not necessarily the same. 7 According to established case law of the European Court of Justice (ECJ), Community law has priority over the national laws of the member states. 8 Primacy of Community law arises from the treaty itself, because realization of the objectives of the EC, particularly the establishment of a common market, would be illusory without the treaty.9 Primacy in this context should not be read as hierar- chy, but be understood in terms of substitution. When a country accedes to membership of the Community, it voluntarily limits its sovereign rights in favor of the Community it has decided to join. In interstate legal transactions, interpretation of the agree- ment is a matter for the contracting parties. However, the actions of the contracting parties of the EC and their subjects are super- vised by the ECJ. Therefore, the ECJ has a unique role. National courts operate within, and can rely on and refer to, their national legal tradition, but that was not the case at the European level. The ECJ had to create such a legal order from the texts of the treaties,

4 See THE LAW OF THE EUROPEAN UNION AND THE EUROPEAN COMMUNITIES 71 (P.J.G. Kapteyn et al. eds., 4th rev. ed. 2008). 5 Joined Cases 90/63 & 91/63, Comm'n v. Lux. & Belg., 1964 E.C.R. 1217. 6 See Case 64/81, Nicolaus Corman & Fils SA v. Hauptzollamt Gronau, 1982 E.C.R. 13. 7 See Case 51/76, Verbond van Nederlandse Ondememingen v. Inspecteur der Invoer- rechten en Accijnzen, 1977 E.C.R. 113. 8 See Case 6/64, Flaminio Costa v. E.N.E.L., 1964 E.C.R. 1194. 9 The supremacy of EC law is a cornerstone principle of Community law but the treaties do not provide for it. A Declaration attached to the Lisbon Treaty provides, however, that "in accordance with the settled case-law of the ECJ, the treaties and the law adopted by the EU on the basis of the treaties have primacy over the law of member states, under the conditions laid down by the said case-law." Treaty of Lisbon Amending the Treaty on European Union and the Treaty Establishing the European Community, Dec. 3, 2007, 2007 O.J. (C 306) 30 [hereinafter Lisbon Treaty], Declaration 17. Although it is not legally binding, this Declaration represents the Member States' recognition of the ECJ case law on primacy of Community law. 2009 EUROPEAN UNION TAX LA W while referencing general principles of law, such as good faith,0 legal certainty, equality, legitimate expectations, proportionality,' and abuse of rights.'1 These principles are derived directly from the treaties, or are common to the legal systems of the member states. There also exists a cooperative relationship between Com- munity law and the laws of the member states. Community law may refer to national law' and national law may supplement Community law 13 or serve to implement it. The extent to which Community law affects member state national laws depends on the legal instrument applied to shape Community policy. The most important legal instruments are regulations and directives. A regu- lation is directly applicable in every member state (i.e., it does not require any action by the national legislature), and it can convey rights to, and impose obligations on, the member states, their bodies, and individuals. 14 A directive, however, is only binding on each member state as to the result to be achieved, and leaves to the national authorities the choice of form and methods. 15 Member states are required to loyally cooperate with Community law, a principle derived by the ECJ from article 10 of the EC treaty. This principle includes the legal obligation of the states to pay damages for losses incurred by individuals as a result of the non-compliance of a state with Community law. 16 Private parties may invoke directly effective provisions of Community law before their national courts, even in cases where national rules con-

10 Proportionality is now included in the European Community Treaty through article 5, and it is generally applicable to Community action. Treaty Establishing the European Community, Feb. 7, 1992, 1992 O.J. (C 224) 1 [hereinafter EC Treaty], arts. 1-5. 11See TAKIS TRIDIMAS, THE GENERAL PRINCIPLES OF EU LAW (2d ed. 2006); HENRY G. SCHERMERS & DENIS F. WAELBROECK, JUDICIAL PROTECTION IN THE EUROPEAN COMMUNITIES (6th ed. 2001). 12 For instance, the nationality requirement plays an important role in determining who benefits from the freedom of establishment or the free movement of employees; and national law determines who is eligible to plead before the ECJ. See EC Treaty, supra note 10, at Protocol 9, Statute of the Court of Justice, art. 19. 13Decisions of the ECJ, for example, are implemented in accordance with the procedures afplicable in the various member states. See id. at art. 256. Id. at art. 249, para. 2. 15 Id. at para. 3. Forms and methods, however, should be chosen in such a way that the stated result or objective of a certain provision in the Directive is also in fact achieved. See Case 48/75, Belg. v. Royer, 1976 E.C.R. 497, para. 75; Case 38/77, Enka v. Inspec- teur der Invoerrechten en Accijnzen Arnhem, 1977 E.C.R. 2203, para. 11. 16 Joined Cases C-6/90 & C-9/90, Francovich v. Italy, 1991 E.C.R. 1-5357, para. 40. FA ULKNER LAW REVIEW Vol. 1-1:53 flict with, or deviate from, Community law. In the latter case, national courts must refrain from applying these national legal measures; not because Community law is of a higher order, but because the national legislature has acted ultra vires.17 The national courts are entrusted with the legal protection of citizens under Commu- nity law 18 and legal actions must follow national legal procedures and national rules on court jurisdiction. In this sense, national courts also act as Community courts. As a general rule, a litigant who wishes to invoke Community law must approach a national court. There exists no direct access to the ECJ for private parties, with respect to Community regulations and directives. Therefore, the impact of Community law on the national systems of law is, first and foremost, in the hands of the national courts. The ECJ is not placed above the national courts. The ECJ and the national courts have distinct jurisdictions, but they cooperate where Community law overlaps national law. Judicial cooperation is a key element in assessing the extent to which Community law affects national law or, from a different perspective, measuring the effectiveness of Community law. Section III of this article ad- dresses these distinctions. Another determining factor of Commu- nity law effectiveness is the method of interpretation used by the courts when called to explain Community law. Section IV covers the methods of interpretation, with an emphasis on tax case law. Section II explains how the choice of tax case law is a natural one because taxation, particularly value added tax, plays a crucial role in realizing the common market. When discussing the methods of interpretation, we will focus on the guidance provided by the ECJ and then examine, through a limited number of examples, the judicial practice in the UK and the Netherlands. Summary and conclusions are found in the final section.

II. THE ESSENTIAL ROLE OF TAXATION IN REALIZING THE COMMON MARKET

The EEC treaty specifies the political and economic objectives of the Community as: (1) the promotion of a harmonious development of economic activities throughout the community; (2) a

17 See Kapteyn, supra note 4, at 78. 18 See EC Treaty, supra note 10, at art. 10. See also Case 33/76, Rewe -Zentralfinanz eG v. Landwirtschaftskammer fiir das Saarland, 1976 E.C.R. 198, para. 5. 2009 EUROPEAN UNION TAX LA W continuous and balanced expansion; (3) an increase in stability; (4) an accelerated raising of the standard of living; and (5) closer relations between the states. The most important tool to realize this is the establishment of a common market. The common market has internal and external components. Externally, its aim is to create equal treatment of foreign trade among the member states. This is realized by the introduction of a common customs tariff. Inter- nally, a single economic area including all member states, would be created, establishing free competition among businesses regardless of their location or nationality. The foundations for the internal component are laid down with the formulation of the so-called four freedoms - the free movement of persons, services, goods and capital. 19 The free movement of goods, the most important of the four freedoms, implies the abolishment of existing and prevention of future trade barriers. This is partially accomplished by founding the common market on a customs union. A customs union implies the establishment of a common outer tariff - replacing the preceding tariffs of the different states and preventing the diversion of trade 21 - and the abolishment of internal import and export duties among the member states. Nevertheless, distortion of intra-community free trade by individual member states would remain possible through discriminatory border tax adjustments (BTAs) for other indirect taxes. Under the destination principle, applied with respect to indirect taxes in the EU as well as in almost all other countries, goods and services should be taxed where they are used, consumed, or en- joyed. Therefore, imports are taxed and exports need to be re- lieved from indirect tax. It would be relatively easy to sponsor domestic production by combining a prohibitive import tax with a generous export restitution system. In this sense, the tax provisions of the treaty serve to guarantee the proper functioning of the common market, particularly the free movement of goods.

19EC Treaty, supra note 10, at arts. 14(2), 23-34, 39-42. 20 Id. at arts. 25-31. 21 If internal customs duties are abolished but Member States maintain their individual rates for trade with third countries, products would be imported into the state with the lowest duties and then forwarded to the state of destination, effectively avoiding the higher rates applied by the latter state. FA ULKNER LA W REVIEW Vol. 1-1:53

The founding states realized that differences between the states in indirect tax systems could be the route to distortion of competition. Based on past experience, 22 they feared that the abolishment of internal customs tariffs, required to constitute the customs union, would simply trigger replacement by discriminatory BTAs for other indirect taxes. One of the problems was that all of the founding member states, with the exception of France, applied gross receipt taxes (GRT). A gross receipt tax is levied at each stage of the supply chain, from manufacturer to final consumer. Under the assumption of the forward shifting of taxes, exact calcu- lation of the domestic tax burden on a certain product cannot be accommodated under a GRT system because the tax actually incurred will depend on the length of the supply chain and the level of vertical integration.23 As a result, it is equally impossible to determine the tax rate to be levied on importation, or to be rebated on exportation, in order to create a level playing field of competition. It was clear to all involved that BTAs based on estimations were in violation of the principles of neutrality and fair competition and, therewith, would threaten the realization of the common market. Harmonization of the general sales tax systems would be required to avoid tariff manipulation at the border, in an effort to create competitive advantages for domestic traders.24 The choice was eventually made to replace the existing GRTs with a non- cumulative sales tax system, the value added tax (VAT), that al-

22 See WALTER HAHN, STEUERPOLITISCHE WILLENSBILDUNGSPROZEBE IN DER EUROPA SCHEN GEMEINSCHAFT: DAS BEISPIEL DER UMSATZSTEUER-HARMONISIERUNG [TAX POLICY PROCESS IN THE EUROPEAN COMMUNITY: THE EXAMPLE OF VAT HARMONIZATION] 35 (Frankfurt am Main, 1988). (The German steel industry maintained it had been discriminated against by France through a turnover tax rate levied on importation that was higher than the average domestic rate on steel products). 23 Gross receipt taxes are still applied, particularly in the United States, at the sub- national level of government. For a concise treatise on the legal and economic complexi- ties of GRTs in the United States, see Robert F. van Brederode, The Re-emergence of Gross Receipt Taxes in the United States, 3 INT VAT MON 182, 182-91 (2008); and John L. Mikesell, Gross Receipt Taxes in State Government Finances: A Review of Their History and Performance, Tax Foundation Background Paper No. 53 (Jan. 2007), available at http://www.taxfoundation.org/files/bp53.pdf. 24 Indeed, in practice the Member States displayed a continuous tendency to employ BTAs as protectionist measures. See HAHN, supra note 22, at 88. 2009 EUROPEAN UNION TAX LA W lows exact calculations of border tax adjustments.25 Like the GRT, a VAT is also levied on the sales that occur at each stage of the supply chain; however, unlike the GRT, a VAT provides a credit for the tax incurred on procurement. A business charges VAT on all its sales (output-VAT) and pays tax on all its purchases (input-VAT). At the end of the tax period, the business will subtract the input-VAT from the output- VAT and remit the difference to the competent Tax Authority (Revenue), or receive a refund in case of an excess input-tax credit. Therefore, under this system, tax accumulation or pyramiding is prevented and the domestic tax burden will always be equivalent to the price times the statutory rate. 26 As a result, exact BTAs are possible to ensure that exported goods are effectively untaxed, and that imported goods are taxed at precisely the same level as domes- tically produced goods. Clearly, indirect tax plays a vital role in assuring the proper functioning of the common market, especially the free movement of goods, by creating a neutral environment, i.e., a level playing field, for competition. The VAT in the EU is based on directives, which need to be implemented into national law. While directives are binding as to their result, member states are free to choose form and means of implementation. Thus, economic distortions may still occur where member states deviate from the principles of the directives, or where the member states apply, in law or practice, different interpretations of the same rules. In those instances, the proper functioning of the common market will depend on the judiciary, charged with guarding the integrity of Community law, i.e., the cooperation between the national courts and the ECJ as well as the guidance provided by the latter to the former in how Commu- nity law should be understood and interpreted.

III. COOPERATION

The cooperative relationship between the national courts, with respect to their role as Community courts, and the ECJ hinges

25 For an overview of the history of tax harmonization in the EU, see ROBERT F. VAN

BREDERODE, SYSTEMS OF GENERAL SALES TAXATION: THEORY, POLICY AND PRACTICE (Kluwer Law Int'l 2009). 26 For a comparison of the different sales tax systems, especially retail sales tax, GRT, and VAT, see ROBERT F. VAN BREDERODE, supra note 25. FA ULKNER LA W RE VIEW Vol. 1-1:53 upon Article 234 EC, which provides the national courts with the eligibility or obligation to raise, and the ECJ with the jurisdiction to answer, preliminary questions on the validity and interpretation of Community law, including tax directives. The text of Article 234 is as follows: "The Court of Justice shall have jurisdiction to give

preliminary rulings concerning:

(a) The interpretation of this Treaty;

(b) The validity and interpretation of acts of the institutions of the Community and of the ECB;

(c) The interpretation of the statutes of bodies established by an act of the Council, where those statutes so provide.

Where such a question is raised before any court or tribunal of a Member State, that court or tribunal may, if it considers that a decision on the question is necessary to enable it to give judgment, request the Court of Justice to give a ruling thereon.

Where any such question is raised in a case pending before a court or tribunal of a Member State against whose decisions there is no judicial remedy under national law, that court or tribunal shall bring the 27 matter before the Court of Justice.,

According to the ECJ, the purpose of this provision is "for the preservation of the Community character of law established by the Treaty" and to ensure that "in all circumstances this law is the same in all states of the Community." 28 In other words, the objective of the provision is to ensure the correct and uniform application of Community law in all member states. The ECJ is not hier- archically placed above the national courts and they have distinct

27 EC Treaty, supra note 10, at art. 234. 28 Case 166/73, Rheinmifhlen-Diisseldorf v. Einfuhr-und Vorratsstelle ffir Getreide und Futtermittel (II), 1974 E.C.R. 33, para. 2. 2009 EUROPEAN UNION TAX LA W jurisdictions. Therefore, the ECJ and the national courts, each within its own jurisdiction, need to cooperate in order to realize this objective. Through Article 234, national courts have the authority, right, and, in some cases, the obligation, to ask preliminary questions if an issue of interpretation or validity is raised before it either by the parties or by the national court itself ex officio. If that occurs, the national court will suspend its2 9proceedings and notify the ECJ of the decision to refer the matter. Although bound by the ECJ's decision, a national court hearing a case is not excluded from raising additional preliminary questions after an ECJ preliminary ruling. For instance, a new reference for a preliminary ruling may be warranted if new facts arise, the application of the first reference leads to complications, or a totally new issue emerges. In any case, however, the preliminary ruling given by the ECJ has "authority of interpretation" 31 for all courts other than the one that raised the question. The functions of the ECJ and the national courts are distinct. The first is limited to the interpretation of Community law and to deciding whether actions by the Community or its institutions are valid. The latter have to apply Community law (as interpreted and explained by the ECJ) to the facts of the case. 32 This functional separation between interpretation and application is not as strict in practice as it may be in theory, because the ECJ renders its ruling within the factual context of the referred case. The facts and circumstances may be so specific that the ECJ's preliminary ruling may not be generally applicable. For instance, the Court was called to decide whether cleaning services provided by a landlord to his residential tenants should be treated as a single bundled service together with the letting (exempt from VAT) or as an independent service (taxed). The Court concluded that it should be considered an independent service, and based its conclusion on the fact that the service was separately in-

29 U.N. Charter art. 23. 30 Case 29/68, Milch-Fett und Eierkontor GmbH v. Hauptzollamt Saarbrticken, 1969 E.C.R. 165, para. 2. 31Case 28/62, Da Costa en Schaake NV et al v. Nederlandse Belastingadministratie, 1963 E.C.R. 11 (joined cases 28, 29, and 30/62). 32 For example, the ECJ will not opine on whether certain national laws are incompatible with Community law, but will provide the referring court with sufficient interpretation to enable it to make such a decision. FA ULKNER LA W REVIEW Vol. 1-1:53 voiced and the tenants could obtain cleaning services from a third- party supplier. The weight of these specific facts prevents the conclusion that ancillary services, as a general rule, should be unbun- 33 dled from the principle leasing service for VAT purposes. Article 234 provides any national court with the right to address the ECJ, but mandates reference by the court of last resort. According to the ECJ, this has to be understood as the highest court in the case rather than the highest court in the national hierar- chy.34 Such a distinction is important since not all issues can be escalated to the highest hierarchical court. Regardless of the referring court, the ECJ will not be able to exercise its jurisdiction without a request for a preliminary ruling. Therefore, the obligation and entitlement of national courts to refer questions is a crucial element of the effectiveness of Community law. In the highly acclaimed CILFIT case, an Italian court of appeals had raised the question as to whether the Article 234 obligation to consult the ECJ was absolute.35 The ECJ pointed out that the obligation to refer preliminary questions of Community law is not absolute. If it were, the Court reasoned, individual persons would have been given direct access to the ECJ. In explaining the parameters of the obligation to consult, the ECJ held that a national court of last resort is obliged to consult the ECJ unless: (1) the issue of Community law has no direct bearing on the outcome of the underlying case; (2) the question raised relates to a point of law on which the ECJ has ruled earlier (acte 6clair6 doctrine); or (3) there is no reasonable doubt about the answers to the question raised (acte clair doctrine). Since the obligation to consult the ECJ is expressly postulated, it is assumed that this represents an exhaustive summary of exceptions. Moreover, the exceptions appear in a fixed order which must be followed by the national courts.

A. Relevance The first exception is basically asking a national court to consider whether a decision on Community law is necessary to render a judgment. If not, the national court is under no obligation to refer the issue to the ECJ. Without this condition, the ECJ

33 Case C-572/07, RLRE Tellmer Property s.r.o. v. Finan6ni feditelstvi v Olsti nad Labem, 2009 O.J., C180/12. 34 Case 6/64, Flaminio Costa v. E.N.E.L, 1964 E.C.R. 61. 35 Case 283/81, Srl CILFIT et al v. Ministry of Health, 1982 E.C.R. 3415. 2009 EUROPEAN UNION TAX LA W would be asked questions with answers that have no bearing to the solution of the case the referring court is hearing. Thus, the relevance of the question is a precondition for the right or obligation to refer an issue to the ECJ. 36 In principle, the assessment of the relevance of a question is the prerogative of the national court. When the national court decides that a preliminary ruling on the interpretation of Community is needed, the ECJ - in accordance with its distinct role and jurisdiction - will neither question nor criticize the grounds of the referring court's assessment. In other words, relevance is presumed.37 The ECJ's role under Article 234 is linked to the resolution of a dispute. Therefore, it does not accept jurisdiction where questions are general or hypothetical in nature. 38 Other than that, and unlike the Supreme Court in the US, the ECJ cannot deny certiorari.

B. Acte Eclaird If the question raised is relevant to the outcome of the case, the national court should determine whether it is exonerated from asking preliminary questions under the second exception. Because it would be unnecessary to approach the ECJ with questions the Court has already answered in earlier cases, it must be determined whether the questions posed in the earlier cases relate to the same point of law in the present case. If so, it must then be determined whether the point of law needs further clarification. The questions do not have to be strictly identical, nor is it required that the previ- ous rulings be given in Article 234 proceedings. 39 Nevertheless, a national court is always entitled to bring a matter before the ECJ if it believes the latter may redefine legal principles or reconsider 40 earlier rulings. Another reason to address the ECJ with a request for a preliminary ruling on matters raised earlier arises when uncertainty exists as to the proper interpretation of these earlier rulings. The

36 Kapteyn et al., supra note 4, at 496. 37 Joint Cases C-94/04, Frederico Cipola v. Rosaria Fazari and C-202/04, Stefano Macrino and Claudia Capodarte v. Roberto Meloni, 2006 E.C.R. 1-11421, para. 25. 38 See, e.g., Case 244/80, Foglia v. Novello, 1981 E.C.R. 3045; Case 93/78, Mattheus v. Doego Fruchtimport und Tiefktihlkost eG, 1978 E.C.R. 2203; Case 112/00, Eugen Schmidberger, Intematuonale Transporte und Planziige v. Republik Osterreich, 2003 E.C.R. 1-5659 (an overview of relevant case law begins in para. 30). 39 Case 283/8 1, CILFIT, 1982 E.C.R. 3415 at para. 14. 40 Id. at para. 15. FA ULKNER LA W REVIEW Vol. 1-1:53

Tellmer case 4 1 is a good example. In this case, commentators using translations disagreed on whether the ruling had only relevance for the particular case (the translation referring to "the tenants") or had general application (the translation referring to "tenants"). This disagreement may not be solved without further interference by the ECJ because the language of the proceedings, 42 Czech, does not know the particle and cannot, therefore, offer any resolve in the matter.

C. Acte Clair The last exceptions offered by the ECJ is generally known as the "acte clair" doctrine.43 As stated by the Court, "the correct application of Community law may be so evident that no reasonable doubt can exist as to the manner in which the question raised must be resolved." 44 This exception appears to have the charm of being obvious and pragmatic; why mandate referral of clearly answered questions? On the other hand, this exception bears the risk of being used by national courts to maintain their autonomy or set aside ECJ case law with which they disagree. As demonstrated by the infamous Cohn-Bendit case, this risk is not hypothetical. In Cohn-Bendit, the French Conseil d'Etat, despite settled case law of the ECJ, disallowed an individual to challenge an administrative decision which conflicted with a directive.45 Perhaps

41 Case C-572/07, RLRE Tellmer Property s.r.o. v. Finan~ni feditelstvi v 0sti nad Labem, 2009 OJ, C 180/12. 42 The language of the proceedings that has force of law is the language of the court requesting a preliminary ruling. 43 The "acte clair" theory was developed in France by the judiciary to offset the executive branch of government's power to interpret international treaties. 44 Case 283/81, CILFIT, 1982 E.C.R. 3415 at para. 16. 45 CE, Dec. 22, 1978, Rec. Lebon 524. Cohn-Bendit was a German national who was deported from France as one of the leaders of the 1968 student revolt in Paris. Several years later he sought to return to pursue a job opportunity, but the government refused to rescind the deportation order, which refusal Cohn-Bendit challenged on the grounds of infringement of Directive 64/221/EEC of 25 February 1964 on the co-ordination of special measures concerning the movement and residence of foreign nationals which are justified on grounds of public policy, public security or public health. 1964 O.J. (056) 850. The lower court (Tribunal Administratif) decided to refer preliminary questions to the ECJ regarding the interpretation of said directive. By doing so, the Tribunal implic- itly recognized the principle of direct effect of a directive. On appeal, the Conseil d'Etat overturned the decision and disallowed the reference. 2009 EUROPEAN UNION TAX LAW cautious for good reason,46 the ECJ decided to attach an absolute condition to the application of the acte clair doctrine. Before com- ing to the conclusion that the answer to a question of Community law is obvious, the national court must be convinced that the matter would be "equally obvious to the courts of the other Member States and to the Court of Justice.'A7 While making this assessment, a national court must take into account that all twenty-three language versions of Community law have equal authenticity and, as a consequence, a comparison of the different versions will be required for its interpretation. 48 In addition, a national court must realize that the nature of Community law is unique in its context and concepts and, therefore, needs to be interpreted separately from national rules. 49 These caveats serve to press upon the national courts the delicacy of their role in realizing uniform interpretation of Community law, and the care that must be taken when deciding not to refer a question to the ECJ.

46 It took until 1989 before the Conseil d'Etat changed course. See CE, Feb. 3, 1989, Rec. Lebon 44; CE, October 20, 1989, Rec. Lebon 190. See, e.g., LIONEL NEVILLE BROWN, JOHN BELL & JEAN-MICHEL GALABERT, French Administrative Law 284-285 (Oxford University Press 5th ed. 1998); TREVOR C. HARTLEY, THE FOUNDATIONS OF EUROPEAN COMMUNITY LAW: AN INTRODUCTION TO THE CONSTITUTIONAL AND ADMINISTRATIVE LAW OF THE EUROPEAN COMMUNITY 250 (Oxford University Press 6th ed. 2007); PHILIPPE MANIN, THE NICOLO CASE OF THE CONSEIL D'ETAT: FRENCH CONSTITUTIONAL LAW AND THE SUPREME ADMINISTRATIVE COURT'S ACCEPTANCE OF THE PRIMACY OF COMMUNITY LAW OVER SUBSEQUENT NATIONAL STATUTE LAW, C.M.L.R. 499 (1991); and THE RELATIONSHIP BETWEEN EUROPEAN COMMUNITY LAW AND NATIONAL LAW: THE CASES, VOL. 11195 (Andrew Oppenheimer ed., Cambridge Univer- sity Press 2003). In Germany, the Bundesfinanzhof was as reluctant in accepting the direct effect of provisions of the Sixth VAT Directive, until the intervention by the Bundesverfal3ungsgericht (Constitutional Court), Case 2 BvR 687/85, 3 C.M.L.R. 1 (1988). See, e.g., TOWARDS A HOMOGENEOUS EC DIRECT TAX LAW: AN ASSESSMENT OF THE MEMBER STATES 31 (Cecile Brokelind ed., I.B.F.D. 2007); and HENRY G. SCHERMERS and DENIS F. WAELBROECK, JUDICIAL PROTECTION IN THE EUROPEAN COMMUNITIES 133 (Leiden 1992); THE RELATIONSHIP BETWEEN EUROPEAN COMMUNITY LAW, supra,232. 47 Case 283/81, CILFIT, 1982 E.C.R. 3415 at para. 16. 48 Id. at para. 18. 49 Id. at paras. 19 and 20. FA ULKNER LA W REVIEW Vol. 1-1:53

IV. INTERPRETATION OF EU TAX LAW

A. Context The ECJ must ensure that the law is observed, in the interpretation and application of the treaty. 50 Above the task of super- vising the actions of all member states and their organs, this includes development of an EU legal order. National courts operate within the context of legal principles and concepts, collectively constituting a national legal tradition. Such a tradition did not exist at the supranational level with the inception of the EC. However, such a legal tradition is essential for the administration of justice, because legal questions cannot be resolved exclusively on the basis of the text of the treaty. For that purpose, the ECJ built a framework for the interpretation of treaty law. This framework supports the acceptance of said law and the interpretation given, because it is founded on general principles of law, such as legal certainty, equality, good faith, proportionality, non-discrimination and abuse of rights.5 Basically, the ECJ fills the void of Community law by applying general principles of law, either directly derived from Community law, or found in the legal traditions of the member states, thus creating unwritten Community law. In essence, the ECJ applies comparative law techniques in its exercise of finding law. However, many principles are also derived from the treaty itself. For example, the principle of loyal cooperation and the principle of state liability for losses caused by state infringements of Community law are both based on article 10 of the treaty. State liability is particularly dealt with in section IV-C. Apart from the legal principles developed by the ECJ for Community law in general, there exist economic principles that dominate VAT. Of course, all taxes rely on economic assumptions such as tax incidence, but for the purpose of EU-VAT, the economic principles on which it is based take precedence over legal provisions. The priority of economic principles, or purpose over legal format, is the direct result of the manner in which VAT was introduced to the EU in 1967. Two directives were enacted. The

50 EEC Treaty art. 220. 51 See Kapteyn et al., supra note 4, at 421. See also H.G. Sc-IRMERs AND D. WAELBROECK, JUDICIAL PROTECTION IN THE EUROPEAN COMMUNITIES (Kluwer Law Int'l 6th ed. 2001). 2009 EUROPEAN UNION TAX LA W

First VAT Directive52 defined the purpose and principle workings of the system, while the Second Directive53 provided the legal format and modalities through which the envisioned system should be realized. Therefore, the First Directive relates to the Second Directive as an explanatory memorandum; and the Second Direc- tive is merely the legal vehicle to deliver the economic structure laid out in the First Directive. From this perspective, the ECJ considers the legal provisions not only to be subordinate, but also to be subservient to the conceptual structure of the tax. To the extent the legal provisions are insufficient to achieve the purpose of the tax, the ECJ will correct them through teleological interpretation, as will be demonstrated in section IV-D. This approach contrasts starkly with the tradition found in Common law countries such as Ireland and the UK. In these countries, literal interpretation of statutory wording is the dominant rule for tax law, unless the result would lead to an absurdity (i.e., the application of literal meaning would clearly defeat the purposes of the Act).54 Because VAT is based on European law, the Common law tradition of jurisprudence in tax law is basically irrelevant. National VAT law must be compliant with EU-VAT law and the national courts need to follow the guidance of the ECJ in interpreting their national law, as further explained in sections IV-B and IV-D. The principles of VAT must be understood and interpreted against the stated purpose of the EU (i.e., the creation of a common market and the supportive role of indirect tax, as explained in section 2). The preamble to the First Directive makes a clear reference to the common market, which "presupposes the prior application in Member States of legislation concerning turnover taxes that will not distort conditions of competition or hinder the free movement of goods and services . . .5 Further, the preamble explains that "[s]uch a system of value added tax achieves the highest de-

52 First (VAT) Directive (67/227/EEC) of April 11, 1967, 1967 O.J. (L 71) 1301. It was repealed when Directive 2006/112 entered into force on January 1, 2007, but the first three paragraphs of article 2, First Directive were reproduced in article 1(2) of Directive 2006/112. 53 Second (VAT) Directive (67/228/EEC) of April 11, 1967, 1967 O.J. (L 71) 1303. This was replaced by the Sixth Directive on 1 January 1978 and subsequently, by Directive 2006/112 on January 1, 2007. 54 House of Lords, 13 December 1978, Jones v. Wrotham Park Settled Estates and another, 1980 A.C. 74, 105. 55 Council Directive 67/227, 1967 O.J. (L 71) 1301. FA ULKNER LA W REVIEW Vol. 1-1:53 gree of simplicity and of neutrality when the tax is levied in as general a manner as possible and when its scope covers all stages of production and distribution and the provision of services. ' '56 The VAT system is defined in more detail in article 2 of the First Directive:

The principle of the common system of value added tax involves the application to goods and services of a general tax on consumption exactly proportional to the price of the goods and services, whatever the number of transactions which take place in the production and distribution process before the stage at which tax is charged.

On each transaction, value added tax, calculated on the price of goods or services at the rate applicable to such goods or services, shall be chargeable after deduction of the amount of value added tax borne directly by the various cost components.

The common system of value added tax shall be57 applied up to and including the retail trade stage.

The main feature of the tax emerging from this definition is an all stage tax (paragraph 3) on consumption (not on production) that has a general application and should include, at least in principle, all goods and services. In addition, the tax does not pyramid (paragraph 1), which is realized by providing a credit for VAT paid on all costs (paragraph 2). The principle of neutrality, introduced in the preamble, of- ten operates in tandem with the general principles of equal treatment and non-discrimination. That should not come as a surprise, because the principle of neutrality is, to an extent, the embodiment of equality and non-discrimination for VAT purposes. Similar goods or services should bear the same tax burden regardless of the length of their respective supply chain. Otherwise, economic distortions would arise, frustrating the free movement of goods and services within the common market. Neutrality, the prohibition of

56 Id. 57 Id. at art. 2. 2009 EUROPEAN UNION TAX LAW tax accumulation, and the right to offset tax incurred on procurement from tax due on sales are central in the jurisprudence of the ECJ.

B. Interpretation in Conformity with a Directive When interpreting national law, a national court must take into account the provisions of Community law, of which the national law is the reflection. Directives are binding on the result, and the obligation to implement a Directive and to achieve its objective or result binds all authorities of a state, including the judiciary. The ECJ formulated this principle for the first time in Von Colson and Kamann.58 This principle has direct consequences for the method of interpretation used by national courts. In applying national law, particularly those provisions of national law imple- menting a Directive, national courts must interpret such laws in light of the wording and purpose of the Directive, in order to achieve the result referred to in the third paragraph of article 189 (249) EC.59 To that end, national courts, making full use of the freedom of judgment granted to them by their national laws, must interpret and apply laws adopted to implement a Directive in con- 60 sistency with the requirements of Community law. For example, English law recognizes the principle that the wording of a law adopted after signature of the EEC treaty, and relating to an international obligation of the national state under the treaty, should be interpreted as having been intended to comply rather than to conflict with such an obligation. Perhaps influ- enced by the approach in his home country, Advocate-General Sir Gordon Slynn endorsed the above legal principle in his opinion to the ECJ in the Marshall case.62 However, he expressly limited the scope of this principle to provisions of national law adopted after the EC treaty or directives. In Slynn's view, applying the principle of interpretation in conformity or consistency with the EC treaty or

58 Case 14/83, Von Colson and Kamann v. Land Nordrhein-Westphalen, 1984 E.C.R. 1891. 59 Id. at para 26. Confirmed in Case C-106/89, Marleasing v. Comercial Internacional de Alimentaci6n, 1990 E.C.R. 1-4135. 6 0 Id. at para 28. 61 Garland v. British Railways Engineering Limited, 1983 2 A.C. 751, 771 (Lord Dip- lock). 62 Case 152/84, Marshall v. Southampton and South-West Hampshire Area Health Au- thority, 1986 E.C.R. 723. FA ULKNER LA W RE VIE W Vol. 1-1:53 directives to national law adopted prior to such time would go too far. The duty of interpretation, in consistency or conformity with Community law, is inherent in the system of the EC treaty because it enables national courts to ensure the effectiveness of Community law, and fulfills the obligations of the member states under article 10 EC.63 To that extent, it is irrelevant whether the national law has been adopted ex ante or ex post of Community law. 64 However, conformity interpretation is not absolute. First, it is limited by general principles of law (section [V-A), such as legal certainty and fundamental rights (e.g., fair trial). 65 Second, interpretation in conformity with a directive is only possible insofar as the national provision provides sufficient latitude to do SO. 6 6 Third, 67 national provisions cannot be interpreted contra legem. National courts have applied conformity interpretation, and we will further examine the approach taken by the Netherlands Supreme Court in relation to VAT. In the Hong Kong case,6 8 the question arose whether a trade organization which supplies services free of charge is a taxable person entitled to recover the VAT it incurred on its procurement. The Hong Kong Trade Develop- ment Council is an organization charged with promoting trade between Hong Kong and other countries. 69 From its Amsterdam of- fices it provides free information and advice about Hong Kong and about trade opportunities with Hong Kong. 70 The Council is funded annually by a fixed grant from the Hong Kong government. The ECJ ruled that activities free of charge do not constitute transactions of a taxable person under the provisions of the second VAT directive (section IV-D). 71 However, that did not fully resolve the

63 Case C-403/01, Bernhard Pfeiffer et al v. Deutsches Rotes Kreuz Kreisverband Wald- shut eV, 2004 E.C.R. 1-8835, para 114. 64 Case C-212/04, Konstantinos Adeneler et al v. Ellinikos Organismos Galaktos, 2006 E.C.R. 1-6057. 65 Case C-105/03, Maria Pupino, 2005 E.C.R. 1-5285, paras. 58-60. 66 In the words of the ECJ "as far as possible," see Case C-397-403/01, BernhardPfeiffer et at, 2004 E.C.R. 1-8835 at para. 113. 67 Case C-212/04, Konstantinos Adeneler et al, 2006 E.C.R. 1-6057 at para. 110. 68 Case 89/81 Staatssecretaris van Financidn v. H.K. Trade Development Council, 1982 E.C.R. 1277. 69 Id. 70 Id. 71 Id. 2009 EUROPEAN UNION TAX LAW case for the referring court, since the text of the directive and the text of the Netherlands VAT Act were distinctively different. The concept of taxable person is defined in article 7 of the Dutch VAT Act as follows: (1) Entrepreneur is everyone who independently conducts a business (2) A business includes: a) a profession b) the exploitation of a capital good for the purpose of gen- erating regular income. 72 In comparison, the Directive defines a taxable person as: "any person who independently and habitually engages in transactions pertaining to the activities of producers, traders or persons providing services, whether or not for gain." 73 The Dutch Supreme Court deemed the concept of entrepreneur within the meaning of Article 7 of the VAT Act, notwithstanding the substantial difference in wording and formulation, to be equal to the concept of taxable person in the Second Directive. A later case demonstrates the liberal approach of the Dutch Supreme Court to the interpretation of legislative intention. 74 A downturn in the real estate market caused many investors to default on their loans. The banks as mortgagee, generally, had no choice but to auction off the property that served as security for the loan, but in many instances the proceeds of the sale were insufficient to cover the total debt. Under the law, the sale of real estate is exempt from VAT, but seller and buyer are entitled to opt for taxation. This option exists to prevent tax accumulation. The bank as

72 Translation by the author. Dutch text: (1)Ondememer is ieder die een bedrijf zelfstandig uitoefent. (2)Waar in deze wet wordt gesproken van bedrijf, wordt daaronder mede verstaan: a. beroep; b. exploitatie van een vermogensbestanddeel om er duurzaam opbrengst uit te verkrijgen.

73 Compare Second Council Directive 67/228, art. 4., with Council Directive 2006/112, art. 9, 2006 O.J. (L 347) 1 (EC) ("'Taxable person' shall mean any person who, independently, carries out in any place any economic activity, whatever the purpose or results of that activity.") and Sixth Council Directive 77/388, 1977 O.J. (L 145) (EC), as amended ("'Taxable person' shall mean any person who independently carries out in any place any economic activity specified in paragraph 2, whatever the purpose or results of that activity."). 74 Case 89/81 Staatssecretaris van Financidn v. H.K. Trade Development Council, 1982 E.C.R. 1277. FA ULKNVER LA W REVIE W Vol. 1-1:53 executor of the real estate 75 would opt for a taxable sale jointly with the buyer, which generally would be a special purpose entity owned by the bank. Under bankruptcy law, the mortgagee has privilege over Revenue in respect of the sales price including the tax component.7 6 In other words, a bank as mortgagee will be able to offset the mortgage balance against the total proceeds of the sale, including the VAT. By exercising the option, banks were able to increase the proceeds by eighteen percent. The buyers would be entitled to a refund of the tax they had paid on the purchase. However, the obligation to remit the tax thus collected by the banks rested upon the debtors as owners of the real estate and not on the banks. As a result, the banks were able to increase the proceeds with an amount of tax that the Revenue never received, but was required to pay back to the bank-owned buyers of the property. Not surprising, the Revenue took an aggressive approach against this practice by denying the refund to the buyers on the grounds that the sale of the real property constituted a transfer of a going concern, which is not taxable, and if tax is erroneously charged, it is not deductible as an input-tax credit. 77 If successful, Revenue would have been able to eliminate the effectiveness of the set-up. According to Article 5(8) of the Sixth Directive (now Arti- cle 19 of Directive 2006/112), member states are allowed to deem that the transfer of a totality of assets, or part thereof, do not constitute a supply of goods.7 8 This provision has been incorporated in the Dutch legislation with Article 31 of the VAT Act.

75 In this sense, the bank would opt on behalf of the owner. 76 Article 59(1) Faillissementswet (Bankruptcy Act). See Hoge Raad der Nederlanden [HR] [Supreme Court of the Netherlands], 6 May 1983, Rentekas, 1984 N.J. 228 (Neth.). The provisions of the Sixth VAT Directive did not provide member states with an opportunity to effectively close this loophole. However, Article 199 of Directive 2006/112/EC has extended the situations in which member states are permitted to introduce reverse charge rules. The Netherlands has made use of this possibility by amending Article 24ba of the Uitvoeringsbesluit Omzetbelasting 1968 to shift the liability for VAT in case of the sale of real estate with an option for taxation to the buyer of the property, effective Janu- ary 1,2008. 77 In this particular case, the refund had already been paid out and Revenue tried to recover this by assessing the buyer on grounds that he had made a tax deduction that was impermissible under the law. 78 Article 19 of Directive 2006/112/EC states: "In the event of a transfer, whether for consideration or not or as a contribution to a company, of a totality of assets or part thereof, Member States may consider that no supply of goods has taken place and that the 2009 EUROPEAN UNION TAXLA W

The purpose of the extension of the concept of taxable person with Section 2(b)79 was to include acts of normal capital man- agement. A person renting out a single property as was the case in this proceeding, for example, is thus a taxable person under this section. The Supreme Court ruled in this case that the transfer of an enterprise as referred to in article 7 section 2(b) is not covered by Article 31. Generally, one would expect that the expansion of a definition provision would apply to the act as a whole and other sections of the Act referring to the definition would not need to be altered to include the extension. However, the Supreme Court reasoned that the expansion did not extend to Article 31 because by not amending the latter section the legislature intended to implement Article 5(8) of the Sixth Directive "in a manner which pro- duces a result materially similar as had the literal wording of the directive been adopted., 80 The Netherlands Supreme Court thus gave priority to interpreting the national law in consistency with the Directive. Another interesting issue arose in this case with relevance to this essay. Because the Supreme Court determined that article 31 of the VAT Act is materially equivalent to article 5(8) of the Sixth Directive, it was also called to determine whether the sale of the single immoveable property could be regarded in terms of the directive as "a totality of assets." In the view of the Supreme Court, that was not the case and there "[could not] reasonably be room for doubt" on the subject. 81 Evidently, from the choice of words, the Supreme Court believed that the "acte claire" doctrine applied in this case and it did not follow a recommendation to ask preliminary questions. No explanation was given, however, as to why this was such a clear case, 82 which is unfortunate given the conditions introduced by the ECJ for the use of the acte clair doctrine.

person to whom the goods are transferred is to be treated as the successor to the trans- feror." 79 Id. at20. 80 Translation by author. 81 Translation by author. 82 1 assume the Court was guided by the use of the plural form: a single immoveable property cannot be a totality of assets, or in other language versions "une universalitd de biens" and "ein Gesdmtverm6gen." FA ULKNER LA W RE VIEW Vol. 1-1:53

C. Application of European Legal Principles There are many legal principles derived by the ECJ, either from the treaty or from the legal traditions of the member states. In connection with the obligation of member states under article 10 of the EC treaty to cooperate with Community law, the principles of equivalence and of effectiveness are particularly relevant to our purpose. Although it is true that the national courts are required to interpret national law in conformity with Community law, the extent to which Community law can be enforced depends on the legal remedies provided for under national law and the conditions under which they can be applied. In this sense, Community law piggybacks national law. Because the national legal systems are considerably divergent in the remedies they provide, the uniform application of Community law is at risk and, as a result, the direct effect and primacy of Community may be negatively affected. The ECJ, however, has explained that there are minimum conditions for the member states to fulfill under their obligation to ensure compliance with Community law under Article 10 EC. The principle of equivalence, as an application of the non- discrimination principle 83 in the specific area of procedural rules and conditions, basically requires that rules for protecting Com- munity rights cannot be less favorable than those governing domestic actions. 84 As a consequence of the cooperative judiciary system of the EU, the task to ensure that the principle of equivalence is, indeed, honored and upheld rests with the national courts. National courts, being solely acquainted with their national procedural rules are therefore, equipped to make such a judgment. According to the ECJ, the principle of effective judicial control reflects "a general principle of law stemming from the constitutional traditions common to the member states"85 and member

83 EC treaty art. 12. 84 First established in Case 33/76 Rewe -Zentralfinanz EG & Rewe-Zentral AG v. Land- wirtschaftskammer flier das Saarland, 1976 E.C.R. 1989, para. 5 and confirmed in Case 45/76, Comet BV v. Produktschap voor Siergewassen, 1976 E.C.R. 2043; Case 265/78, H. Ferwerda BV v. Produktschap voor Vee en Vlees, 1980 E.C.R. 617; Case C-261/95, Rosalba Palmisani v. Istituto Nazionale della Previdenza Sociale (INPS), 1997 O.J. (C 271)2. 85 Case C-432/05, Unibet Ltd v Justitiekanslern, 2007 O.J. (C 95) 9, para. 37. This principle is found in Articles 6 and 13 of the European Convention for the Protection of Hu- man Rights and Fundamental Freedoms (Rome, Nov. 7, 1950, Council of Europe, Euro- pean Treaty Series, No. 5), and Article 47 of the Charter of Fundamental Rights of the 2009 EUROPEAN UNION TAX LA W states have the obligation under Article 10 EC to ensure judicial protection of an individual's right under Community law. This means that the national courts must interpret the procedural rules governing actions brought before them in such a manner as to enable to attain this objective, 87 which may entail setting aside national legal rules when required to ensure the effectiveness of the protection. 88 The principles of equivalence and effectiveness in- teract where the latter sets parameters for exercising the former. Unacceptable is, thus, the situation where equivalence exists de iure but is rendered impotent de facto, in other words, where the exercise of the rights 89 is made virtually impossible or excessively difficult. Andrea Francovich and Danila Bonifaci and others v. It- aly9° introduced the doctrine of state liability enabling individuals to obtain reparation when their rights are violated by a breach of Community law for which a member state can be held responsible.91 According to the ECJ, the reparation by the member state is essential when it has not implemented a Directive in due time and consequently the individuals are unable to enforce their rights granted by Community law before the national courts. The ECJ founded its decision on two arguments. Firstly, it concluded that such a liability was inherent to the system of the EC treaty and, secondly, the Court derived the liability from the obligation to cooperate of Article 10 EC. The principle was further developed in

European Union, (Nice, 2000 O.J. (C 364) 1) and, as such, is recognized as a fundamental right. 86 Case C-432/05, Unibet Ltd. v Justitiekanslern, 2007 O.J. (C 95) 9, para. 38. 87 Id. at para. 44. 88 See Case 70/77, Simmenthal SpA v Amministrazione delle finanze (Simmenthal I), 1978 E.C.R. 1453, and Case C-213/89, The Queen v. Sec'y of State for Transport, ex 9arte Factortame (Factortame I), 1990 E.C.R. 1-2433. 9 See Paul P. Craig & Grdinne De Bfirca, EU LAW: TEXT, CASES, AND MATERIALS 309 (Oxford University Press 4th ed. 2007); P.J.G. Kapteyn et al., supra note 4, at 545; and Margot Horspool & Matthew Humphreys, EUROPEAN UNION LAW 202 (Oxford Univer- sity Press 4th ed. 2006). 90 Joined Cases C-6/90 and C-9/90, Andrea Francovich and Danila Bonifaci and others v. Italy, 1991 E.C.R. 1-5357. 91 See Craig, & De Btirca, supra note 89, at 328; Kapteyn et al., supra note 4, at 556; Roy W. Davis, Liability in Damagesfor a Breach of Community Law: Some Reflection on the Question of Who to Sue and the Concept of "the State," 31 EUR. L. REv. 69 (2006). FA ULKNER LA W REVIEW Vol. 1-1:53 subsequent cases. In Brasserie du Pcheur,92 the ECJ made clear that the principle of state liability applies to all breaches of Com- munity law regardless which organ of the State was responsible for the breach, even if that is the legislature or a national court.9 3 It stressed, "[s]ince the Treaty contains no provision expressly and specifically governing the consequences of breaches of Commu- nity law by Member States, it is for the Court, in pursuance of the task conferred on it by Article 164 of the Treaty of ensuring that in the interpretation and application of the Treaty the law is observed, to rule on such a question. . . ."94 In Dillenkofer, et al v. Bundes- repubik Deutshland,95 the ECJ further developed the conditions for state liability, when it held that: Failure to take any measure to transpose a directive in order to achieve the result it prescribes within the period laid down for that purpose constitutes per se a serious breach of Community law and consequently gives rise to a right of reparation for individuals suffering injury if the result prescribed by the directive entails the grant to individuals of rights whose content is identifiable and a causal link exists between the breach of the State' 9 6 s obligation and the loss and damage suffered. The activist approach of the ECJ tightens national autonomy and sovereignty; and some member states have argued.that a general right to compensation under Community law is not inherent and could only be created by national legislation. Interestingly, however, the Treaty of Lisbon9 7 inserted article 9F which states, "[M]ember States shall provide remedies sufficient to ensure effective legal protection in the fields covered by Union law." 98 It appears that the Lisbon Treaty codifies the ECJ's principles of effec-

92 Joined Cases 46 & 48/93, Brasserie du P~cheur SA v. Bundesrepublik Deutschland and The Queen v. Sec'y of State for Trans. ex parte Factortame Ltd., 1996 E.C.R. 1-1029, Paras. 31-32. Case C-224/01, Gerhard K6bler v. Republik Osterreich, [2003] E.C.R. 1-13, para. 1; and Case C- 173/03, Traghetti del Mediterraneo SpA v. Repubblica italiana, 2006 E.C.R. 1-5. 94 Case C-46/93 Brasserie du Pcheur SA v. Bundesrepublik Deutschland, 1996 E.C.R. I- 1029, para. 2. 95 Joined Cases C-178, 179, 188, 189, & 190/94, Erich Dillenkofer, et al v. Federal Re- 6ublic of Germany, 1996 E.C.R. 1-4845. Id. at para. 27. 97 Treaty of Lisbon amending the Treaty on European Union and the Treaty establishing the European Community, signed in Lisbon, art. 9, 2007 O.J. (C 306) 1. 98 Id. 2009 EUROPEAN UNION TAX LA W tiveness and equivalence. Although the Lisbon Treaty has not created general rules on state liability, one could argue that the Treaty also codifies the principles developed in the Francovichcase. As a demonstration of law in action, in 2001 the ECJ ruled that the UK tax provisions, concerning payment of advanced cor- poration tax as it affected subsidiary companies whose parent company was outside the UK, contravened article 52 (now 43) of the EC treaty. 99 Subsequently, Sempra Metals Ltd. (formerly Met- allgesellschaft Ltd.) filed suit to recover restitution in the form of interest in respect of the tax paid prematurely. The House of Lords realized that Community law requires that a remedy be offered in domestic law. Under English law, a claimant can recover damages for losses caused by breach of contract or a tort with the exception of claims for interest losses.100 However, in 1952 it was recognized that loss due to late payment might be recoverable if it constituted special damage. 0 1 It seems illogical to allow the recovery of special and not of general damages for loss of the use of money. Sim- ple interest is available under statute and both simple and compound interest can be awarded in equity. However, where the court invokes equity in aid of the common law, awarding com- of the pound interest was perceived02 as unauthorized usurpation function of legislature. 1 In this case, the claim was for restitution, i.e., a claim for the time value of money by which Revenue was unjustly enriched. The House of Lords changed direction by recognizing the possibility of rewarding compound interest under the restitutionary remedy at common law. Since the law of restitution is the law of gain- based recovery, the enrichment needs to be valued from the perspective of the enrichee. In other words, the interest rate appropri- ate for the defendant's circumstances needs to be applied, i.e., the

99 Joined Cases C-397& 410/98, Metallgesellschaf Ltd. and others, Hoechst AG and Hoechst U.K. Ltd. v. Comm'rs. of Inland Revenue, [2001] E.C.R. 1-1727. 100 London, Chatham and Dover Ry. Co. v. South E. Ry. Co., 1893 A.C. 429. 101Trans. Trust SPRL v. Danubian Trading Co. Ltd., [1952] 2 Q.B. 297. 102 Westdeutsche Landesbank Girozentrale v. Islington London Borough Council, 1996 A.C. 669. FA ULKNER LA W REVIEW Vol. 1-1:53

interest rate at which03 the government could borrow in the market at the relevant times. 1 Sempra Metal Ltd. was a corporate tax case, and the subsequent question raised was whether compound interest can also be awarded in cases of overpayment of VAT, notwithstanding a provision in the UK statutory law that precludes the award of compound interest.10 4 An opportunity to resolve the issue arose when UK Revenue lost the Fleming and Condg Nast cases'0 5 and was required to pay out input-VAT credits that had been unrecoverable due to statute of limitation arrangements, which were in violation of direct effective Community law. 10 6 Without a transitional period, both the principle of legitimate expectations and the principle of effectiveness were violated. UK Revenue had to honor older claims and paid back with simple interest, which triggered an ava- lanche of legal claims for the awarding of compound interest. Generally, these claims are made first for restitution with the interest at a rate calculated by referencing the average cost of government borrowing during the relevant periods; and, secondly, for damages at a reasonable commercial interest rate. Of course, effectiveness is the primary underlying legal principle for the claim, since the House of Lords had established a violation of Community law. Through the principle of equivalence, the Sempra ruling serves as grounds for awarding compound interest for VAT, because rules for protecting Community rights cannot be less favorable than those governing domestic actions.

D. TeleologicalInterpretation A good example of the approach taken by the ECJ is its ruling on a preliminary question posed by the Netherlands Supreme

103Sempra Metals Ltd. v. Comm'rs. of Inland Revenue and another, 2007 1 A.C. 561 (H.L.). 104 Value Added Tax Act 1994, UK ST 1994, ch. 23 pt. IV § 78. 105 Fleming (t/a Bodycraft) and Cond6 Nast Publ'ns. Ltd. v. Her Majesty's Revenue and Customs, 2008 U.K.H.L. 2. 106 The UK had reduced the time limit for making input-VAT claims from six to three years without allowing for a transitional period during which a claim could be made in cases where a right to recovery of overpaid tax already existed, which the House of Lords found to be in violation of article 17 of the sixth VAT Directive. See Case C-62/00, Marks and Spencer plc v. Comm'rs. of Customs and Excise, 2002 E.C.R. 1-6325, para. 38; see also Case C-255/00, Grundig Italiana SpA v. Ministero delle Finanze, 2002 E.C.R. 1-8003, para. 37. 2009 EUROPEAN UNION TAX LA W

Court in the Hong Kong case,10 7 earlier discussed in Section 1I-B. The question was whether an organization that provides services free of charge constitutes a taxable person under the second VAT10 8 directive, eligible for a credit of VAT paid on its procurement. The ECJ noted that the text of the Second Directive did not provide any clarity as to this point and then followed a reasoning based on the purpose of the directive.10 9 The court started its reasoning by noting that the value added tax is applied up to and including the retail stage and is calculated on the price of goods and services, but that tax incurred on inputs is deducted. 110 The court then noted that the tax is no longer deductible when the chain of transactions reaches the final consumer.111 Finally, the ECJ concludes that when services are provided free of charge no tax can be due since there exists no basis of assessment, i.e., price.112 "In such circumstances the person providing services must be assimilated to a final consumer because he3 is at the final stage of the production and distribution chain."1 In another Dutch case,1 14 the ECJ again judged the eligibility of input-VAT credit, this time in relation to activities in the preparatory phase of a business. Mr. and Mrs. Rompelman ac- quired future title to two commercially zoned units in premises under construction, which would be leased (subject to VAT) to traders. 15 They sought to recover the VAT charged on the in- stallment payments, which Revenue declined on the ground that the actual exploitation of the units had not yet commenced. Since the outcome of the case hinged on the interpretation of the term "exploitation" in the definition article of the directive, references

107 Case 89/81, Staatssecretaris van Financien v. H.K. Trade Dev. Council, 1982 E.C.R. 1277. 108 Id. 109Id. III Id. 112 Case 89/81, Staatssecretaris van Financian v. H.K. Trade Dev. Council, 1982 E.C.R. 1277. 113Id. atpara. 10. 114 Case 268/83, D.A. Rompelman and E.A. Rompelman-Van Deelen v. Minister van Financidn, 1985 E.C.R. 655. 1151d. FA ULKNER LA W RE VIEW Vol. 1-1:53 for a preliminary ruling were made. 116 The text of article 4 of the sixth VAT directive is as follows:

1. "Taxable person" shall mean any person who independently carries out in any place any economic activity specified in paragraph 2, whatever the purpose or results of that activity.

2. The economic activities referred to in paragraph 1 shall comprise all activities of producers, traders and persons supplying services including mining and agricultural activities and activities of the pro- fessions. The exploitation of tangible or intangible property for the purpose of obtaining income there-

from on a continuing 1basis17 shall also be considered an economic activity.

After explaining the background and purpose of the VAT system, the ECJ considered that economic activities may consist of several consecutive transactions. Therefore, "preparatory acts, such as the acquisition of assets. . . which form part of those transactions must themselves be treated as constituting economic activity."' 8 The ECJ then motivated its decision by referring to the neutrality principle. "The principle that [VAT] should be neutral as regards the tax burden on a business requires that the first investment expenditure incurred for the purposes of and with the view to commencing a business must be regarded as an economic activity."11 9 Otherwise, a trader would not be able to recover VAT on his costs, which would, in the words of the Court, "create an arbitrary distinction between investment expenditure incurred before the actual exploitation of immovable property and expenditure incurred during exploitation."' 120 This is a good example of the inter-exchangeability of the principles of neutrality and equal treatment.

116 Id. 117 Sixth Council Directive 77/388/ECC, art. 4, 1977 O.J. (L 145) 1, 2 (EC). 118 Case 268/83, D.A. Rompelman and E.A. Rompelman-Van Deelen v. Minister van Financidn, 1985 E.C.R. 655. 119 Id. 120 Id. at para. 23. 2009 EUROPEAN UNION TAX LA W

A subsequent matter arose in the INZO case. 12 1 INZO commissioned a profitability study with a view to develop a sea- water desalination process. On the basis of this study, it decided to abandon the project and, as a result, INZO never actually made any supplies to anyone. It shall be clear that INZO qualified as a taxable person based on the earlier Rompelman ruling. However, the business never reached the operational phase and was in fact ter- minated in its infancy. The question raised was whether INZO's status as a taxable person could be retrospectively revoked with a loss of the right to recover input-VAT, when it became clear that INZO would never make any supplies. The ECJ rejected this approach because a retrospective change of status would infringe the general principle of legal certainty. In addition, this approach would breach the neutrality principle because it creates a difference in tax burden between those who are and those who are not successful in launching their business. However, the reasoning of the Court seemed to contradict the literal text of article 17 of the sixth VAT directive,1 22 which regulated right to deduct input-VAT at the time of the proceedings, because the text limits the deduction of VAT to inputs "used for the purposes of his taxable transactions."' 23 Where in Rompelman124 the taxable activities occurred at a laterpoint in time, in INZO there were no taxable transactions at all.' 5 The ECJ found a solution to do justice to the economic principles of VAT by reading "his taxable transactions ' '126 as a reference to transactions intended at the time the input tax was incurred. As demonstrated, the ECJ is a remarkable "activist" in interpreting the VAT law in such a manner that it fulfills its economic objections. As discussed in section IV-A, the ECJ develops unwritten Community law on the basis of general principles of law or economic principles in matters of taxation, when there is a lacuna in

121 Case C- 110/94, Intercommunale voor Zeewaterontzilting (INZO ) v. Belgian State, 1996 E.C.R. 1-857. 122 Now Article 168 of Directive 2006/112. 123 Case C-1 10/94, Intercommunale voor Zeewaterontzilting (INZO) v. Belgian State, 1996 E.C.R. 1-857, para. 4. 124 Case 268/83, D.A. Rompelman and E.A. Rompelman-Van Deelen v. Minister van Financidn, 1985 E.C.R. 655, para. 5. 125 Case C-1 10/94, Intercommunale voor Zeewaterontzilting (INZO), 1996 E.C.R. 1-857 atpara. 9. Id. at para. 4. FA ULKNER LA W REVIEW Vol. 1-1:53 the design of, for example, a directive. An example of such a lacuna is found in Securento,127 which deals with the attribution of input VAT when the recipient of the inputs, on the one hand, makes both taxable and exempt supplies (economic activities) and, on the other hand, also has a separate activity that does not amount to a business (non-economic activities). The solution for this situation seems obvious. Input-VAT directly related to taxable output should be recoverable, input-VAT related to exempt sales and non-business activities should not be recoverable, and the tax on general inputs that cannot be directly allocated should be recoverable pro rata, i.e., on the basis of appor- tionment. However, although the directive offers an apportion- ment mechanism for mixed use, the wording of the text is inaccu- rate in that it apparently has missed to anticipate the possibility of non-business activities. The relevant text of the directive states: The proportion deductible ... shall be made up of a frac- tion having: as numerator, the total amount, exclusive of value added tax, of turnover per year attributable to transactions in respect of which value added tax is deductible . . . as denominator, the total amount, exclusive of value added tax, of turnover per year attributable to transactions included in the numerator and to 128 transactions in respect of which VAT is not deductible. The above rules cover expenditures exclusively related to economic activities with a distinction between taxable economic activities, which give rise to the right to deduct, and exempt economic activities, which do not. Arguably, under a literal interpretation of this provision, input-tax attributable to the non-economic activities would be recoverable. The ECJ points out that the rules governing deduction are intended to provide complete relief to a trader for VAT paid in the course of economic activities. 129 Over- head inputs can only give rise to VAT recovery if, and to the extent, they directly relate to taxable output.130 Where the directive does not contain the guidance necessary to make a correct calcula- tion of the proportion of tax that is recoverable, the member states

127 Case C-437/06, Securenta G6ttinger Immobilienanlagen und Verm6gensmanagement AG v. Finanzamt Gtttingen, 2008 E.C.R. 1-1597. 128 Article 19 of the Sixth Directive and Article 174 of Directive 2006/112. 129 Case C-437/06, Securenta G6ttinger Immobilienanlagen und Verm6gensmanagement AG v. Finanzamt G6ttingen, 2008 E.C.R. 1-1597, para. 25. 130 Id. at para. 27. 2009 EUROPEAN UNION TAX LA W are required to exercise that power, "hav[ing] regard to the aims and broad logic of the [D]irective ....,,131 Again we can conclude that the ECJ takes the purpose of the VAT system as the foundation for its reasoning. Where the directive is incomplete, the member states, through their judiciary, are required to fill the lacuna in a manner that ensures the effectiveness of Community law. Another area where the application of VAT required the intervention of the ECJ is the practice of promotion sales using different types of coupons. Boots is a national retail chain in the UK, which attempted to increase its sales volume through a promotion scheme involving coupons printed on the packaging of certain products. 132 Customers received these coupons free of charge when purchasing the products. 133 The bearer of such a coupon was entitled to a price reduction equal to the nominal value indicated on the coupon upon the subsequent purchase of the same or certain other products indicated on the coupon.1 34 Boots accounted for VAT on the discounted price. 135 Revenue, however, was of the opinion that VAT was also due on the value of the surrendered coupon.'36 Central in this case was the interpretation of the concept of taxable amount as found in the VAT directive, the text of which is as follows: [E]verything which constitutes the consideration which has been or is to be obtained by the supplier from the purchaser, the customer or a third party ....137 The taxable amount shall not include:

b. price discounts and rebates allowed to the customer and 38 accounted for at the time of supply.'

131Id. at para. 35. 132Case C-126/88, Boots Co. plc v. Comm'rs of Customs and Excise, 1990 E.C.R. I- 1235, para. 3. 133Id. 134Id. 135 Id.at para. 5. 136 Id. at para. 6. 137 Article 11 A (1)(a) of the Sixth Directive, supra note 73 (in effect at the time of the 73. see also Article 73 of Directive 2006/112, supra note ?roceedings);38 Article 11 A (2) of the Sixth Directive (see supra note 73); Article 79 of Directive 2006/112 (see supra note 73). FA ULKNER LA W REVIEW Vol. 1-1:53

According to the ECJ, discounts and rebates "constitute a reduction of the price at which an article is lawfully offered to the customer, since the seller agrees to forego the sum presented by the rebate in order precisely to induce the customer to buy the article."' 139 The exclusion of discounts and rebates is only an application of the definition of taxable amount, which, as the court has explained in earlier cases, 14 is the consideration actually received. 141 The ECJ did not accept the United Kingdom's argument that the coupon represented value to Boots and should, for that reason, be included in the taxable amount. 142 The coupon only incorporated the obligation 43 of Boots to allow the bearer a price reduction. 1 The ECJ takes this much further in Elida Gibbs Ltd. v. Commissioners of Customs & Excise.144 The focus in this case is not on the retailer but on the position of the manufacturer. Again, a coupon is printed on the wrapping of certain goods entitling the consumer to a discount on subsequent purchases. There are two variations: 1) the coupon is presented to the retailer for an imme- diate discount of the retail price, and the retailer is subsequently reimbursed by the manufacturer, or 2) the customer pays full retail price, mails the coupon to the manufacturer, and receives a rebate from the manufacturer. Under both scenarios, the retailer receives the full retail price. Where the manufacturer pays part of the price to the retailer, this constitutes a third party payment, covered by the main definition rule of the VAT directive. The question arising in Elida Gibbs was whether the manufacturer could reduce the taxable amount of its sale to the wholesaler or retailer1 45 with the re-

139 Case C-126/88, Boots Co. plc v. Comm'rs of Customs and Excise, 1990 E.C.R. I- 1235, para. 18. 140 Id. atpara. 19. 141 Case 230/87, Naturally Yours Cosmetics Ltd. v. Comm'rs of Customs and Excise, 1988 E.C.R. 6365, para. 18. 142 Case C-126/88, Boots Co. plc v. Comm'rs of Customs and Excise, 1990 E.C.R. I- 1235, para. 20-21 (The coupon is a bearer note that does have a monetary value to consumers, but it is difficult to understand how it could have monetary value for Boots once the coupon has been surrendered, since the obligation and entitlement embodied by the coupon, which offset each other, are now in the same hand.). 143 Id. at para. 21. 144Case C-317/94, Elida Gibbs Ltd. v. Comm'rs of Customs and Excise, 1996 E.C.R. I- 05339. 145Elida Gibbs sold sometimes directly to the retailer and sometimes through a wholesaler, but this makes no difference for the principle of the case. 2009 EUROPEAN UNION TAX LA W bate, which was paid out to the final consumer. Elida Gibbs Ltd. was of the opinion that this rebate should be considered as a retro- active discount of its own sales price. The distinction to the Boots case is clear: Boots gave a discount to its own customer whereas the manufacturer in Elida Gibbs gave a discount to the final customer of another business downstream in the supply chain. Nor- mally, a downstream supply of goods should be matched with an upstream flow of payments, and rebates take place between subsequent stages of the supply chain. In this case, however, the rebate, like the knight in chess, skipped one or two stages. This fact pat- tern is difficult to reconcile with the literal wording of the relevant provisions of the directive, which gave reason for Advocate- General Fennelly to advise that the taxable amount of the manufacturer should not be adjusted. The discounts given to one's own customer are excluded from the taxable amount. However, the customer of the manufacturer, the wholesaler or retailer, did not receive a discount. The discount was given downstream the supply chain, to the final consumer who did not directly procure the product from the manufacturer. In addition, under the second scenario, the discount was not accounted for at the time of the supply as required by the directive's provision but instead paid out at the time that the coupon was surrendered to the manufacturer. In the view of the Advocate General, a direct link is needed between the reduction and the relevant taxable transaction. Where the Directive contains no mechanism for the manufacturer's taxable amount to be reduced by reference to its payments to the consumers, the payments by the manufacturer to the consumers must be regarded as an arrangement under which the manufacturer met part of the consumer's cost of acquiring the goods without any further tax impli- cations. The ECJ, however, approached the problem from the perspective of the purpose of the EU VAT system. VAT is supposed to be a tax on final consumption, and, by intention, businesses should not carry any burden of the tax because they only operate as collectors of the tax and not as the actual taxpayer. The court de- scribes the principles of the tax and the consequences derived from them as follows: The basic principle of the VAT system is that it is intended to tax only the final consumer. Consequently, the taxable amount serving as a basis for the VAT to be collected by the tax authorities cannot exceed the consideration actually paid by the final con- FA ULKNER LA W REVIE W Vol. 1-1:53 sumer which is the basis for calculating the VAT ultimately borne by him .... 146 It follows that, having regard in each case to the machinery of the VAT system, its operation and the role of the intermediaries, the tax authorities may not in any circumstances 147 charge an amount exceeding the tax paid by the final consumer. Notwithstanding the above formulation of the principles, the court still needed to somehow reconcile these principles with the mechanics of the tax as laid down in the directive. First, the ECJ acknowledges that the provisions regarding price reductions refer "to the normal case of contractual relations entered into directly between two contracting parties, which are modified subsequently."' 148 This observation, however, did not pose a serious hurdle for the court to arrive at the desired result. In the same paragraph, the court continues: "the fact remains, however, that the provision is an expression of the principle, emphasized above, that the position of taxable persons must be neutral.' ' 149 Appar- ently, in the view of the ECJ, the provisions of the directive are not in violation of the neutrality principle but embody it. It therefore follows that, "in order to ensure observance of the principle of neutrality,"' 50 account should be taken of rebates that miss a link in the contractual chain. "Otherwise, the tax authorities would receive by way of VAT a sum greater than that actually paid by the final 5 1 consumer, at the expense of the taxable person.' This case clearly demonstrates that, in the view of the ECJ, the economic principles of the VAT should take precedence over legal provisions at all times. The provisions of the VAT directive serve to realize certain economic outcomes. If and where, due to imperfections in their design, they are unable to deliver the economic requirements of VAT, the member states and their judiciary must nevertheless ensure that these results are realized by improv- ing the failing mechanism.

146 Case C-317/94, Elida Gibbs Ltd. v. Comm'rs of Customs and Excise, 1996 E.C.R. I- 05339, para. 19. 147 Id. at para. 24. 148 Id. at para. 31. 149 Id. at para. 31. 150 Id. 151Id. 2009 EUROPEAN UNION TAX LA W

V. CONCLUSIONS

Despite shared features, the EU is not a federation of states but a common market. Apart from the ECJ, which functions to an extent like the Supreme Court of Community law, there is no separate lower court system comparable to federal district and appeal courts in the US. In fact, the national courts fulfill a double role where they are also charged with the application and interpretation of Community law. Cooperation between the ECJ and the national courts is imperative for the effectiveness of Community law. The tool provided in the EC treaty to accomplish this is the right and obligation of the national courts to address the ECJ with preliminary questions regarding Community law and the jurisdiction of the ECJ to answer those questions. The right and obligation to address the ECJ are not absolute. There is no reason to ask preliminary questions if the point of law is either clear or has been clarified in earlier rulings of the ECJ. However, the national courts should not draw that conclusion lightly. It can be anticipated that the national courts hold different views when their starting point in legal reasoning originates in distinct legal traditions. Common methods of interpretation are necessary to ensure uniform and equal administration of justice under Community law. The ECJ is remarkably proactive in its interpretation of EU law and is, in fact, the motor behind the European integration. Al- though the word "activist" is somewhat negatively charged in the US, it seems to make sense within the EU context. It is important to realize that the ECJ has to operate within a context deprived of a legal tradition and, therefore, has to develop its own "European" tradition. That provides the ECJ with significant room to move, unprecedented from the perspective of courts of last resort operat- ing within established traditions. As demonstrated by several VAT cases, the ECJ does not accept a legalistic approach in the field of taxation. The courts' reasoning is based on the purpose and economic objectives of the tax where the directives are merely the legal vehicles to deliver those. Where the mechanics of a VAT directive fail to deliver the intended result, the court has shown no hesitation in interpreting the text in a manner that is consistent with the purpose of the tax. The ECJ applies legal principles that it de- rives either from the treaty or from the national traditions of the member states. An example of legal reasoning on this basis is a recent case in the U.K. seeking (either in damages or in restitution) 88 FA ULKNER LA W REVIEW Vol. 1-1:53 compound interest as fair compensation for losses caused by breach of Community law by the tax authorities.